This is a complete guide for both beginners and experts in South Africa about what bitcoin is and how it works. We will break down bitcoin into simple concepts, so by the end of this guide, you will understand why bitcoin was created and the technology behind bitcoin.
We have broken this guide down into 8 easy sections. So feel free to skip sections you already understand and direct to what you want to understand.
Bitcoin has been a hot topic this year, and will likely remain a hot topic into the future due to reasons that will become clear throughout this guide. When you run a quick search on Google or Yahoo or Bing, searching “What is Bitcoin?” you will probably get something like: “Bitcoin is a cryptocurrency…”
Okay. fine, that probably doesn’t really tell you what bitcoin is, because you probably don’t understand what cryptocurrency, so what is a cryptocurrency?
Another likely answer will be, “Bitcoin is a digital currency.” Okay, great, I can access and transfer my South African rands online on my FNB Internet Banking or mobile app, does that mean the Rand is also a digital currency?
The most interesting of all answers is: “Bitcoin is the first decentralized open source, peer-to-peer network that is powered by its users with no central authority or middlemen using blockchain technology.”
Great, this leaves you even more confused.
Bitcoin may seem like a near impossible technical concept to understand, yet in reality it is way simpler than most people think when we describe it using analogies. So first, let’s think about how easy it is to shake another person’s hand, give them a high five, or interact with them physically.
As long as you are within arm’s length of the other person, it’s easy to just simply reach out and shake their hand. Or imagine if you had a bottle of water in front of you, how easy it is to simply reach out and have a drink of water. Pretty straightforward, right?
Now let’s imagine that in order to shake someone’s hand, you had to shake another person’s hand, who then shook that person’s hand for you.
Or imagine that in order to have a drink of water from a bottle in front of you, another person had to pick it up, put the water in their mouth, and then put it into your mouth.
That’s just crazy, right?
Well, that’s essentially how banks, credit cards, and our traditional financial system currently works. When you swipe your bank card to pay for groceries at the store, your bank is taking your money from your account, giving it to the grocery store for you, and then charging you for it.
This is the case with checks, credit cards, debit cards, ACH transfers, and any exchange of money. It’s so ingrained in South Africa and the greater part of the known world that it seems completely normal and okay for the most part.
The reality is, the only person who has anything to gain in this arrangement is not even a person: it’s the banks. They make a profit from storing, transferring, controlling, and issuing loans off from money you deposit into banks under the guise that:
1) “it’s safer there,” which is not the case,
2) that you aren’t smart or qualified enough to manage your own wealth without their services.
So this case of someone basically profiting from shaking a person’s hand for you, that you could just as easily shake directly yourself, is how our “modern” financial system works.
Well, bitcoin is just like shaking someone’s hand directly or taking a drink of water from a bottle directly, except with value exchange; and the best part is, you don’t even have to be an arms-length away to do it.
With bitcoin, you can send and receive value directly to anyone around the world, anytime. One of the hangups people have with understanding bitcoin is just another thing we have been conditioned to accept as standard business practice: which is a separation between value and storage or transference of that value.
So we own and hold fiat like the South African Rand as something representative of value, yet use completely separate mechanisms to actually use it, store it, and move it around.
For example, you have South African Rands representing value, and you have an FNB bank account to store it in, and you have an FNB Black Card card to spend it, and maybe even a PayPal account to buy, sell, and manage value as well.
This is a very normal concept we are accustomed to because that was pretty much all that’s been available, until the past decade. So instead of having fiat represent value and paying financial businesses like ABSA and Standard Bank to move it around and store it, Bitcoin is both value and a means to transfer, store, and manage that value.
This is because bitcoin is both a digital value and it’s a network that can store and transfer the bits of digital value. Value and usage of the value is simply one unified system in the case of bitcoin.
The creator of bitcoin is our very own modern day Shakespeare mystery, as the only thing we know about this person or persons is their pseudonym, Satoshi Nakamoto.
The true identity of this person or group of people has remained anonymous. Satoshi Nakamoto created bitcoin and the bitcoin network using blockchain technology. And blockchain is simply a method of record-keeping using math and computer science, as opposed to accountants and bookkeepers.
What most South Africans don’t know is, the concept of blockchain was actually outlined back in 1991 and Satoshi was the first one to apply blockchain use just under 20 years later in 2009 with bitcoin. We will talk about how the bitcoin blockchain works in more detail later in this guide.
In the following section, we will point out the problems with financial institutions and our current monetary system that prompted Satoshi to create bitcoin. Bitcoin was created as a way for people to store and send value around the world, anytime, anywhere, at virtually no cost, without using a financial business or fiat currency.
In our current financial system, bank accounts and credit cards are luxuries most people around the world and particularly South Africans don’t qualify for, don’t have access to, or simply can’t afford. Even if you do have bank accounts and credit cards, they can be frozen, restricted, and closed at any time without warning, and except on each and every holiday known to mankind, most banks only operate only 9 AM to 5 PM on weekdays.
Even if all of your accounts are clear for the moment, the only thing you store in them or use within them, are debt repayment instruments. Yes, our hard-earned money, stored in bank accounts is just debt repayment instruments created by the government so you can pay debts like credit cards, mortgages, bills, loans, etc.
But doesn’t the money have inherent value as well, isn’t it backed by something representative of the issuing country’s GDP, or something similar? Well, let’s talk about what all this “money” in our bank accounts really represent.
Money is a bit of an abstract word, and its true definition is a medium of exchange in the form of coins and banknotes, in addition to being assets, property, and resources owned by someone or something.
The type of money that is stored in traditional bank accounts is called fiat. And the basic definition of fiat is this: Fiat is a pronouncement, arbitrary decree, or command given by a person or group of people that have absolute authority to enforce it.
So when you combine the word fiat, with the word money: the definition of fiat money is a legal form of money issued and backed by the government and “backed by the government” means that the government made an arbitrary decree that fiat money, or the South African Rand, is to be used in our economy as a medium exchange for goods and services.
Essentially, the government has commanded us or told us our fiat Rands should be used to buy goods and services in our country. If you’re not convinced, just think about what happened in our neighbour to the north, Zimbabwe. Whenever the government ran out of money, President Robert Mugabe and the then governor of the Reserve Bank of Zimbabwe would agree to print money particularly to pay salaries of civil servants.
So all of the “money” or rands we have in our bank accounts are intrinsically useless, valueless, and are only a form of debt repayment or medium of exchange. Satoshi knew this and created bitcoin to deal with the following challenges:
Next, let’s break down how blockchain works because once you understand the core principles of bitcoin’s underlying technology, you will start to see how bitcoin is far superior to both fiat money and our current financial system at large.
The primary element that makes bitcoin so unique as a digital currency and payment network is its underlying blockchain foundation. So let’s talk about how blockchain makes bitcoin possible using principles of the universe, like math and science, without the need for accountants, bookkeepers, banks, or governments.
The most plain and simple way to understand the word “blockchain” is by separating the word “block” from the word “chain.”
Imagine a list of transactions showing payments sent to and from people getting listed one after the other as they occur. Then, once the maximum amount of transaction data in the list has been reached, the list of records becomes a block of data.
This block of data is then added behind a previous block of transaction data linked together with a chain. Great, so the word “blockchain” simply represents groups of transaction data linked together.
The plainest and simple explanation of the bitcoin blockchain is that its records of bitcoin transaction data stored on a network of computers around the world. And there are 3 pillars of blockchain technology that make it unique:
The word decentralization in blockchain is twofold. One, it means that instead of data being stored in one place, like one computer in one office, data is stored on multiple computers all around the world. And two, decentralization also means that no one person, corporation, government, authority, or any entity controls any aspect of the data recording and storage process.
For example, currently, we have a central banking system controlled by the government, a central authority, who issues fiat that can reside in accounts controlled by Reserve Bank of South Africa or other similar centralized entities.
Each of these entities is in complete control of where and how their data is recorded, stored, and managed. They can decide what type of servers to use, where the servers are located, and how their security protocols work.
In contrast, blockchain allows transaction data management to be decentralized on a network of computers around the world using open-source software. And any changes to the blockchain protocol have to go through a consensus process that no one person, company, or government has control over to protect the integrity of the network.
So instead of a centralized entity like the South African Revenue Authority (SARS) deciding how and where all their data is stored on certain servers in certain locations, a decentralized blockchain network is distributed on many devices all over the world.
That is the essence of the “decentralization”
Transparency in blockchain describes how transaction data is recorded on a public ledger that is available for anyone to see. This ledger of transactions is saved on a network of computers around the world which makes it impossible for the data to be changed or altered.
To better understand the value of transparency in data recording, storage, and management, let’s compare these two scenarios: Currently, most citizens of South Africa do not know how the R500 Billion for COVID-19 aid was spent.
We just have to take the government’s word for it or draw our own conclusions from media stories. And even if the government had to show us where every cent went, it would be very easy for them to forge or manipulate any data they chose to share with us, since they control their own data and create their own reports. You can see how this scenario is not exactly transparent, nor trustworthy.
Let’s imagine a different scenario where all South African citizens had access to a live, running ledger of where every single stimulus dollar was spent by the government at any moment in time.
Basically,/ everyone could see a full disclosure of how our government is managing our money. And this scenario is more trustworthy and transparent.
Immutability means that the data recorded and stored on the blockchain cannot be changed, forged, or altered. This is achieved through math and computer science, more specifically cryptography & blockchain hashing processes.
Blockchain uses math and computer science to record and store data in a way that ensures once new data is verified, it is unmodifiable, it’s distributed across a vast network of computers around the world so it’s hard to destroy, and no one person or entity controls the data or network, creating a transparent environment.
And bitcoin is a use case of this blockchain technology. Its use being a digital currency that people can use as a form of payment to send to and from each other or hold as a store of value, similar to gold.
Now that you are familiar with some of blockchain’s important features, let’s talk about some technical details specific to how bitcoin works.
So the bitcoin blockchain is basically a live, running ledger of all the bitcoin transactions. The structure of the bitcoin blockchain is a network of computers around the world with bitcoin software installed on them.
Each time a bitcoin transaction occurs, that data is transferred throughout the network of computers. Computers that maintain blockchain networks are commonly referred to as nodes.
And these computers validate transactions, add the transactions to their copy of the ledger, and then broadcast the ledger changes to all of the other computers on the network in the form of a block.
Each block of transactions has a programmed maximum amount of data it can store, so on average, every 10 minutes or so, a new block of bitcoin transactions is created, validated, and published to the bitcoin blockchain.
So who are all these people with bitcoin software installed on their computers around the world validating transactions and why would they want to do this? Great, bitcoin transactions are verified and broadcasted to the network via a process called mining and this process is completed by miners.
Miners are people or pools of people that use computers with bitcoin software installed on them to maintain the bitcoin blockchain. Maintaining the blockchain involves keeping the bitcoin transaction ledger clean, consistent, and permanent by grouping new transactions into blocks and publishing them to the rest of the network for verification.
For a new block to be accepted by the network, miners compete with each other using computing power to verify transactions in exchange for rewards. These rewards are in place to incentivize miners to participate in the mining process to ensure the bitcoin network continues to be audited and essentially maintained.
The technical details of mining are complex, so I break it down in another audio guide all about mining. Without losing sight of this guide, the basic concept you need to know about bitcoin mining is that miners are rewarded with bitcoin each time they verify a new block of transactions.
Mining rewards are a combination of newly minted bitcoins that were not previously circulating, and transaction fees of bitcoin that were already circulating.
There are existing bitcoins currently in circulation, and there are some bitcoins not circulating right now. Which brings us to the next section.
A characteristic Satashi Nakotomo programmed into bitcoin was a maximum supply. The total amount of bitcoin that can ever exist is 21 million bitcoins. Satoshi implemented a maximum supply of bitcoin so it would mirror an inflation rate similar to gold.
And thinking back to the mining process we discussed in the previous section, you will start to see many similarities between bitcoin and gold, which were all by design. Bitcoin was created to be like a digital gold of sorts.
Currently, 18 million bitcoins are in circulation of the 21 million total supply. New bitcoins are minted into circulation during the mining process when new blocks are verified. At the moment, the amount of new bitcoin entering circulation is 6.25 bitcoin per block, and it takes approximately 10 minutes to verify a block.
Another characteristic Satoshi programmed into bitcoin are what’s called “halving” events. Halving refers to the reduction in bitcoin block rewards issued to miners by half. Block rewards halve every 210,000th block, which on average turns out to be approximately every four years.
May of 2020 was the most recent halving, which decreased the block reward from 12.5 bitcoins to the current rate of 6.25 bitcoin. About 900 new bitcoins enter into circulation every day until the next halving event, making the annual inflation rate of 1.8%.
The advantage of having a fixed supply is that bitcoin’s inflation rate will eventually reach 0% once the last bitcoin has been mined. The last bitcoin will be mined in the year 2140, which is about 120 years from now.
A fixed supply and high demand create scarcity, which typically increases the value of assets like gold, and can be expected to play out in the case of bitcoin as well based on its performance in past halving events which we will discuss in the seventh section.
Another advantage of a fixed supply is you don’t experience issues like we will experience in the future with the South African Rand. Bitcoin was programmed in such a way that new bitcoins enter into circulation at a fixed rate that halves overtime to curb inflation, and the new bitcoins are distributed to miners proportionally to the amount of work they produce.
The South African Rand, on the other hand, doesn’t have a fixed supply, so at any time, the government can print more fiat. And who decides who gets the money? Where does all this money go? Newly printed fiat is not equally distributed to people who are producing in the economy like in the case of bitcoin miners.
The people or corporations closest to the government’s money printer get first dibs on the new, free money, typically in the form of low-interest loans, which is not a fair, neutral way of adding South African Rands into circulation.
In response to the Coronavirus pandemic, the Reserve Bank of South Africa has recently printed an unprecedented amount of fiat that will eventually result in hyperinflation and devaluation of the Rand, which will basically reduce the purchasing power of the South African Rand over time.
In contrast, bitcoin over time will increase in purchasing power as the available supply continues to decrease, so long as demand remains steady and most likely increases in these times of uncertainty.
But what if there’s not enough bitcoin to go around? What if 21 million bitcoins aren’t enough for everyone who wants to use or store it over time?
Luckily, similar to the South African Rand, bitcoin is actually divisible. So like how the rand can be divided into smaller units like 5 cents, 10 cents, 20 cents, and 50 cents, bitcoin can also be divided.
This is a table showing the different denominations of bitcoin from 1 unit of bitcoin, all the way to the smallest unit of bitcoin, which are called Satoshi’s or “Sats,” for short.
One Satoshi is one hundred millionth of a bitcoin, or bitcoin to the eighth decimal place, which is represented as a decimal followed by 7 zeros and then a 1. Smaller units of bitcoin and standard denominations make using bitcoin as a day-to-day currency much easier, as it would be too limited to try and pay for things with one whole unit of bitcoin, which at the time of this guide is worth around R300,000.00.
That would be like trying to buy a bottle of water with a gold bar, which wouldn’t really work. So you can see how bitcoin is actually more divisible than the South African Rand and most other fiat currencies as well, as the smallest denomination of the South African Rand is a cent representing 1/100th of a rand, while satoshis represent a whopping 1/hundred millionth of a bitcoin.
Satoshi Nakamoto knew that in order for a currency to work in a society as a medium of exchange, it must be easily broken down into smaller increments so it can easily represent a value equal to any and all goods or services available in an economy for exchange.
And bitcoin is more than sufficiently divisible, as it allows for quadrillions of individual units of Satoshis to be distributed to anyone around the world.
To store and transfer bitcoin, you need to use bitcoin wallets. There are several types of bitcoin wallets and some types are more secure than others. The two general categories of bitcoin wallets are hot storage and cold storage.
Hot storage, or software wallets, are wallets that are on devices connected to the internet like a computer or smartphone or an exchange.
Cold storage are wallets on devices not connected to the internet, like dedicated cryptocurrency hardware wallet devices like Ledger, Trezor, or BC Vault.
Other forms of cold storage include paper wallets and more durable materials like wood or fireproof metal wallets.
Cold storage hardware wallets are the safest type of bitcoin wallet to use since they are not connected to the internet where you risk getting hacked. And all bitcoin wallets generally consist of two things: private keys and public keys.
Keys are also referred to as addresses. So what is a private key or address? A private key in regards to bitcoin wallets, is a secret 256-bit alphanumeric number that is randomly generated using cryptographic math functions.
The degree of randomness used when generating a private key is so random, it’s been described that there are more possibilities of creating unique private keys than there are atoms that exist in the entire known universe.
So you can see how the odds of creating a duplicate private key are nearly impossible. A private key is the most important thing to keep safe as a bitcoin holder. Because your private key gives complete and full control over any bitcoins associated with it.
Using a private key, anyone can make irreversible bitcoin transactions, meaning they can send bitcoin to any other person or place without you being able to undo the transaction. Now from the private key, a public key or address is generated.
Public keys, similar to private keys, are also an alphanumeric number, however, it is derived directly from a corresponding private key using cryptographic math functions.
And the function operates in such a way that it’s impossible to reverse engineer a public key to figure out the corresponding private key. A public key or address is used only to receive bitcoin from others.
You cannot use a public key to send bitcoins – only receive. You could post your public key on a public website and anyone who comes across it can send you bitcoin.
Put simple, private keys are for sending or spending bitcoins and public keys are for receiving bitcoins.
Let’s explore an analogy to better understand this concept. Think about your traditional bank account if you have one. You can provide anyone with your account number to receive an electronic transfer from them.
However, using just an account number, they cannot access your actual bank account to spend your money. Think of the bank account number as your public key or address. Anyone can use it to send you money.
Now, let’s think about your online banking account username and password. Using your online bank account login credentials, depending on how your bank operates, someone could access your account and transfer funds from it.
Think of your online bank account username and password combination as your private key. If someone logs in as you, they could initiate transfers of funds out of your account.
Simple enough right?
The simplest answer is supply and demand. As demand for bitcoins increases and the supply decreases, it causes the price of bitcoin to increase. Great, but why would people want or demand bitcoin in the first place? Why would anyone want to trade their valueless fiat debt repayment instrument for magic internet nerd money?
Well, since the Coronavirus pandemic, a lot of people have lost faith in the governments, stock market, and financial system at large. And since the printing of trillions of Rands and US Dollars in the United States, even cash reserves are a losing proposition because printing more money is the same thing as trying to cut a pizza into smaller pieces to feed more people. It’s not going to end well.
Satoshi revealed his idea for bitcoin in 2008, in the midst of our last financial crisis and launched it the following year in 2009. Bitcoin was actually designed to be a hedge against our current financial system.
Bitcoin was born during a crisis and was built to survive crises. It’s been around for over a decade now, and for the first time ever, we are seeing bitcoin decouple from the traditional stock markets and prove itself as a safe haven in times of uncertainty.
In the past, bitcoin and the cryptocurrency market’s performance typically correlated with the stock market. However, in recent months, we are now seeing the stock market open and close at a loss, while the crypto markets increase.
This inverse movement reveals that cryptocurrency is separating, or decoupling, from traditional financial assets and becoming more distinguished as a different type of financial asset.
One that people are just starting to flock to during times of uncertainty, transforming their fiat into something they
believe will retain its value over time, and almost certainly increase substantially over time.
As we discussed previously, programmed halving events decrease the supply of new bitcoin entering into circulation. The price of bitcoin increases when supply decreases and demand increases. New supply of bitcoin decreased by 50% and demand for bitcoin during these uncertain times are increasing.
If you look at the historical data of the price of bitcoin following previous halving events, you see the price increasing nearly 10 fold, several months after the halving takes place.
After the first halving in 2012, bitcoin went from around R100.00 per bitcoin to over R1,000.00 per bitcoin. After the second halving in 2016, bitcoin went from R10,000.00 up to R200,000.00 and settled around R100,000.00 per bitcoin.
The third halving happened in mid-May of 2020. Is R1,000,000.00 per bitcoin in the cards in the coming years? Is R10,000,000 per bitcoin possible in the future?
Well, if you reference data from past halving events which occurred during the longest traditional market bull run in history, and consider the most recent halving that happened during one of the worst global financial crises we’ve ever experienced, anything is possible in crypto. From R0 per bitcoin to over a hundred million rands per bitcoin.
And bitcoin is proving to be one of the only stores of value we have the opportunity to invest in, where we can experience our wealth exponentially increasing over time.
Buying Bitcoin can be broken down into 3 simple steps: